Commodities always seem to be in the spotlight, with oil, gold, corn, soy, and hogs grabbing daily headlines. While the commodities market may appear sophisticated, commodity mutual funds offer an accessible way for almost any investor to participate in this exciting arena.
Exploring Fund Types The term “commodity fund” actually covers a range of investment options, including:
Commodity Funds: These funds directly hold commodities like gold bullion, making them true commodity funds.
Commodity Funds That Hold Futures: Most investors aren’t keen on physical delivery of commodities like hogs, corn, or oil. Instead, they seek to profit from price changes. Investing in commodity-linked derivative instruments, such as futures contracts, offers a popular mutual fund strategy for achieving this objective.
Natural Resource Funds: These funds invest in companies involved in commodity-related industries, such as energy, mining, oil drilling, and agriculture. Although they don’t typically hold actual commodities or futures contracts, they provide exposure to the commodities markets through proxy investments.
Combination Funds: Some funds combine actual commodities with commodity futures. For example, gold funds may include both physical gold bullion and futures contracts.
Diverse Investment Strategies Commodity funds also offer a variety of investment strategies, including active management and passive management. Active portfolios aim to outperform a benchmark index by actively buying and selling assets. On the other hand, passive portfolios seek to replicate a benchmark index and match its performance. Passive strategies can be implemented through index funds or exchange-traded funds (ETFs).
The Pros and Cons of Commodity Fund Investments Commodities bring valuable portfolio diversification. By investing in futures contracts or actual commodities, you add a component that goes beyond the traditional stock and bond investments. Historically, commodities have shown a low correlation with equity markets, meaning they don’t always move in sync with market trends. This low correlation is a key objective for many investors seeking to diversify their portfolios.
Commodities also offer exciting upside potential. As raw materials used in construction, agriculture, and various industries, they are subject to the laws of supply and demand. When demand rises, prices generally follow suit, leading to potential profits for investors.
Furthermore, commodities serve as a hedge against inflation, providing a valuable safeguard for your investments.
Consider the Other Side It’s important to note that commodities markets can be highly volatile, characterized by abrupt price swings and long periods of stability. Within just a few days, prices can go from record highs to record lows. To grasp the extent of these fluctuations, take a closer look at the price movements of gold over the past 30 years or copper in 2008.
Additionally, consider the composition of various mutual funds and the benchmark indexes they track. Energy often dominates many commodities indexes, representing over half of the index. Consequently, if a mutual fund seeks to replicate such an index, it may allocate more than half of its assets to energy. To avoid over-concentration, some funds impose limits on the percentage of the portfolio invested in a single commodity.
Do Your Homework While commodities offer intriguing investments and strategies, the commodities markets are complex and may be less familiar to most investors compared to the stock or bond markets. Before diving into commodity funds, take the time to thoroughly read the fund’s prospectus and annual report. Ensure that you understand what you’re buying and how it fits into your portfolio. Pay close attention to the fund’s holdings and be aware of the weight assigned to specific market sectors. Adjust your investment plan accordingly for other parts of your portfolio. And always keep in mind the volatile nature of commodities markets, considering